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Heterogeneous Credit Constraints and Optimal Monetary Policy

Author

Listed:
  • Marco Ortiz

    (Universidad del Pacífico)

  • Gerardo Herrera

    (Universidad del Pacífico)

Abstract

The optimal response to adverse external shocks in an economy involves the choice of a exchange rate policy. While the traditional Mundell-Flemming inspired theories support a floating exchange rate, evidence shows that central banks intervene in foreign exchange markets regularly. One of the reasons for these interventions relies on the consequences of large depreciations triggering negative balance sheet effects in economies with dollarized liabilities as shown by Benigno et al. (2013) and Devereux and Poon (2011). This paper extends this literature by introducing heterogeneity in credit constraints across sectors. Our findings support that "leaning against the wind" policy responses are optimal even when only a sector of the economy is affected by the credit constraints. Thus, relative price distortions provide an additional justification for these policies. We show that the vulnerability of the economy to large negative external shocks depends not only on the overall unhedged foreign debt, but also on its distribution across sectors.

Suggested Citation

  • Marco Ortiz & Gerardo Herrera, 2020. "Heterogeneous Credit Constraints and Optimal Monetary Policy," Working Papers 164, Peruvian Economic Association.
    • Handle: RePEc:apc:wpaper:164
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    References listed on IDEAS

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    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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